A blog about economics, finance, business and corporate governance. My background is in economics, with degrees from Columbia and Johns Hopkins. A career in international development, equity capital markets and as a corporate finance chief and board member lead me to think about events in a different way--hence the blog's name.

Monday, September 10, 2012

Draghi Has No Solutions For Euro

After watching the market reach new highs, and after reading all manner of learned European commentary on European banking regulation, I still believe that the Draghi's chest thumping about saving the euro and the banking system is empty posturing. Our reasoning has been laid out before, but let's see what's new this week.

I'm really surprised by the dearth of any sensible economic commentary from the European think tanks, e.g. the Institute for New Economic Thinking to name one. Some of their pundits put their faith in the ECB and its unlimited ability to buy bonds, manage interest rates, control EU-wide inflation rates, and manage the bank regulation and resolution process for 6,000 banks in the union. This latter objective would be carried out in conjunction with partners, like the IMF.

The IMF as an institution can barely carry out its current charters: it a large bureaucracy and not an effective multinational bank auditor and regulator.

The INET says that the balance sheet of the ECB won't be an impediment to unlimited bond buying, because its equity doesn't matter. But, the equity holders are the member states which provide the capital. They are the "owners." The relative contributions of the equity holders should be what determines the composition of the governing board, in a normal institutional arrangement. Why on earth would Germany agree to this kind of madcap arrangement without the concomitant protections?

The austerity programs continue to founder, and we learn this morning that the proposed menu of Greek austerity measures has been rejected by "international inspectors." These inspector Clouseaus are demanding that the Greek government come up with alternative measures. How long can a Greek government continue to play this game out and lose face?

Meanwhile, the Spanish government is in denial, like the Black Knight in Monty Python and the Holy Grail. It was thought to be the "new sick man of Europe" in 2009, and now its banking sector is on the brink because of the failure of its own monetary and regulatory mechanisms. It is now where the Black Knight was at the end of the Python sketch. The Spanish Prime Minister hasn't decided if he wants "to ask for help" yet. The ECB can't handle this critically ill patient.

Italy lurks in the background as the patient to enter the emergency ward. It unfortunately is nominally the third biggest economy in the EU.

Even France has begun talk about "austerity measures," although this will probably prove to have been for show by the politically inept Hollande government.

For national labor productivity ratios to re-equilibrate among EU states, Germany would have to run a higher inflation rate. Which government is going to go along with a scheme like this, with the German economy already going into a deep slowdown? Despite Chancellor Merkel's more dovish cooing about the euro, nothing much has changed for her coalition. The policy options on the table now are blank checks, with no accountability, and bad outcomes for the stronger players in the EU.

Uncle Ben Bernanke will have to deliver good news for the markets this week if the bull leg is going to continue upward.

It all gets back to political unwillingness to cede national sovereignty and to the balkanization of economic interests. Without the mechanism of country exchange rates to adjust labor productivity and without meaningful labor market and regulatory reforms, even a more powerful ECB cannot paper over the flaws in the current system, no matter how big its balance sheet becomes.